Structural Change Model
Structural change model is a
development mechanism by which
underdeveloped economies transform/
reshaping their economic structure from
a heavy dominated traditional/
conventional/subsistence/agriculture
sector to a more modern/urbanized/
capitalist/industrial/manufacturing and
service sector in the economy.
• Structural change refers to dramatic shifts
which is often sparked by technological
innovation or new economic paradigms.
• It can also be caused by global shifts in the
pools of capital and labor, changes in
resource availability (changes in supply and
demand of resources) and changes in the
political as well as institutional landscape.
• Natural disasters and geopolitical conflict
may also drive structural change.
LEWIS THEORY:
UNLIMITED SUPPLIES OF LABOUR
Sir William Arthur Lewis
(23 Jan 1915 – 15 June 1991)
Professor of Political Economy
at Princeton University, British.
Lewis was awarded by the
Nobel Memorial Prize in
Economic Sciences in 1979.
An eminent theoretical model of
economic development focused on the
structural transformation of subsistence
economy put forwarded by Lewis with
‘Unlimited Supply of Labor' in 1954.
This two sector model became the
general theory of development process
in developing nations during 1960s and
early 1970s, and it is still applied in
developing countries.
Lewis believed that unlimited supply of
labor is available at subsistence wage
rate in underdeveloped countries.
Economic development is result of capital
accumulation.
Capital accumulation is result of
withdrawal of surplus labour from
subsistence sector and their
employment in capitalist sector.
Features
i- Two sector or dualistic economy:
Lewis divides underdeveloped countries into
dual economy i.e. subsistence sector and
capitalist sector.
a- Subsistence sector:
Lewis defines – subsistence sector is that part of
economy which is traditional, overpopulated,
rural and absence of using reproductive capital
(wealth as money or property/machine/
buildings that can be use in the production of
more wealth).
In this sector, the output per head is quite low
and people are generally backward, illiterate,
unskilled, and traditional type of agriculture.
This sector is over populated with infinitely
elastic supply of labour at the given wage
rate.
Existence of diminishing marginal product of
labour and unlimited supply of labour, it is
possible to withdraw labour form subsistence
sector without decrease in total output.
Lewis says such labour as surplus labour.
b- Capitalist sector:
It is that part of economy which uses
reproducible capital so that output per head
is high, people are generally advance,
literate, skilled, sophisticated.
The use of capital is controlled by capitalist
sector which hires the services of laborers
for wages in mines, factories and
manufacturing purposes etc. for earning
more profits.
ii- Competitive markets
This model is based on the assumption of
perfect competition in both factor and
product markets so that wage and prices are
perfectly competitive.
iii- No serious bottleneck
Lewis assumes no serious problem will arise in
the process of transformation labour from
subsistence to capitalist sector because
capitalist sector needs skilled workers for its
expansion and development.
Similarly, unskilled labor is only temporary
bottleneck which can be removed by
providing training facilities for development.
iv- Capitalist surplus
Unlimited supply of labor is converted into
surplus gain (Lewis termed as capitalist
surplus) which is an essential prerequisite of
economic growth & development.
Capitalist surplus is generated with the
difference between the marginal
productivity of labor and the capitalist wage
rate.
Capitalist surplus is reinvested in the new capital
assets by the leading entrepreneurs.
It leads to capital formation/accumulation in the
economy that creates new job opportunities for
the unemployed laborers existing in the
subsistence sector at capitalist wage rate.
Hence, circular process of surplus increases
investment and employment that fulfils the
objective of capitalists to maximize their profits.
This process of development continues till the
supply of labor becomes inelastic and surplus
labor disappears in agriculture sector.
The model
In Lewis model, subsistence sector is
characterized by zero marginal labor
productivity that permits surplus labor
withdrawn from the traditional agricultural
sector without any loss of output to high
productive modern/urban/industrial sector.
Primary focus of the model is process of labor
transfer and growth of output and
employment in the modern sector (industrial
sector).
The speed of labor transformation is
determined by the accelerate industrial
investment of capitalist profit and capital
accumulation in the modern sector.
Lewis assumed that the level of wage rate in
the urban industrial sector is constant and
over than the wage rate of traditional
agriculture sector.
At the constant urban wage, the supply curve
of labor is considered to be perfectly elastic.
The right panel of diagram (figure-b) is portrayed
traditional agriculture sector in which upper part
shows how subsistence food production varies with
increases in labor inputs (LA) for a given capital stock
(KA) as well as technology (TA).
In lower diagram, average and marginal product of
labor curves (APLA, MPLA) are derived from the basis
of total product curve (TPA).
The quantity of agricultural labor (QLA) is the same on
both horizontal axes and is expressed as Lewis
described unlimited supply of labor with scarce/
constant capital and technology so that law of
variable proportion operates in production process.
Lewis has made two assumptions about the
subsistence/traditional sector;
i-there is surplus labor in the sense that MPLA is
zero
ii-workers share equally in the output so that the
real wage is determined by the average product
of labor.
Assume that there are LA agricultural workers
producing TPA food which is shared equally as
WA wage per person. The marginal product of LA
workers is zero and surplus labor will be the
excess of LA as shown in the lower part of the
figure (b).
Left panel of diagram (figure-a) portrays total
product (TPM) curves for the modern
industrial sector with the labor input (LM),
capital stock (KM) and technology (TM) all are
variable.
On the horizontal axes, the quantity of labor
employed to produce output say TPM1 with
capital stock KM1 is expressed (in thousands
of workers as L1).
In modern sector, capital stock is allowed to
increase form KM1 to KM2 to KM3 as a result of
the investment of profits by capitalists.
This will cause to shift upward total product
curve from TPM (KM1) to TPM (KM2) to TPM
(KM3) as above of figure.
Here, we have modern sector marginal product
of labor (MPLM) is derived from the TPM
curves of the figure.
Under the assumption of perfectly competitive
labor markets in the modern sector, the
marginal product of labor curves are in fact
the actual demand curves for labor.
Lewis assumes that at urban wage WM is above
than rural wage WA and modern sector
employers can hire more workers from rural.
Given the fixed supply of capital KM1 in the initial
stage of modern sector growth, the demand
curve for labor is determined by declining
marginal product of labor D1 (KM1) = MPLM
Profits maximizing modern sector employers are
assumed to hire laborers to the point where
marginal physical product is equal to real wage i.
e. the point F at which demand and supply of
labor are equal so that modern sector
employment will equal to L1
In this situation, total output is OD1FL1 and
total wage paid to workers is OWMFL1 so that
profit is WMD1F and all these profits are
reinvested which increase total capital stock
in the modern sector from KM1 to KM2
This larger capital stock causes the total
product curve shift to TPM (KM2) which in turn
induce a rise in marginal product i.e.
demand curve of labor as D2 (KM2) so that
new equilibrium will be established at point
G with L2 workers employed.
In this case, total output rises to OD2GL2 while
total wage OWMGL2 and profits is WMD2G.
Again, all profits are reinvested that leads to
capital stock KM3 and shift total product to TPM
(KM3) and raising the level of employment to L3.
This process of modern-sector expansion (growth
and development) is assumed to continue until
surplus of rural labor is absorbed by the modern
sector through higher WM than WA
This is called turning point by which an economy
begins to look like a developed economy.
Lewis point out the following reasons to the end of
growth process in model;
i-If the capitalist sector expands so rapidly by
employing labor of subsistence sector. The wage
rate of modern sector begins to rise that
decrease profit and capital investment for the
expansion of modern sector which retards
growth and development.
ii-If the workers of capitalist sector would like to
capitalist/higher living standard, they demand
high wages & labor union would force for raising
wage so that it makes cutting down profits of
capitalists and stop the further expansion.
Criticisms
i- Unrealistic assumption
The assumption of prevailing constant wage rate in
modern/capitalist sector until the supply of
labor is absorbed from the subsistence sector
seems to be unrealistic because wage rate
would rise over time even in industrial sector of
the underdeveloped country.
Similarly, the assumption of unlimited supply of
labor in subsistence sector is not relevant
because surplus labor exist in rural areas even
there is full employment in urban sector.
ii- One sided theory
This theory has neglected to develop
subsistence/agriculture sector and
focus only modern/industrial sector
over the development.
Similarly, the development of industrial
sector is based on supply of raw
materials and food grains which will
possible to supply from agriculture
sector.
iii- Inadequate supply of skill labor
Lewis assumes limited supply of skilled
labor is only temporary bottleneck that
can be removed by providing training
and better education facility but the
problem of skill labor could not
overcome easily as claimed by theory
due to backward economy of various
ground in practically.
iv- Lack of entrepreneurship
This theory is based on sufficient
entrepreneurship to accumulate and operate
capital to induce reinvestment and economic
development.
But in underdeveloped countries, a rising level
of profits does not equally induce a rising
level of reinvestment because entrepreneurs
may turn to speculators to catch extra gains
by various grounds (real estate, share and
security etc) in such economy.
v- Neglects of effective demand
Lewis believed that the total production
of capitalist is equally demanded
(consumed or exported).
But, if there is shortage of demand for
capitalist product, the entire process of
development will shut down.
Hence, multiplier process does not
operate in LDCs.
vi- Labor migration is not perfect
Transfer of labor force from
agricultural to industrial sector is
not easy as theory claimed because
laborers have deep affection on
originated land area and family as
well as socio-cultural relation.
vii- Savings are not made only by capitalist
Lewis say almost saving is made by
capitalist in LDCs.
But in some cases like Japan, saving is
made by low middle and income groups
in order to future uncertainty and high
income groups would prefer precious
articles and real estate etc. due to
demonstration effect.
viii- Use of capital intensive technique
Capitalist may use more capital
intensive (labor-saving) technique
of production rather than labor-
intensive which may labor
displacement rather than labor
absorption from agriculture sector.
In figure, MP2 has a greater negative slope
than MP1 due to additions to the capital
stock embody labor-saving technique which
requires less labor per unit of output.
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